David Smith on Global Silver Squeeze: “Paper Pushers” Being Marginalized

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Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.

Coming up we’ll hear from David Smith of The Morgan Report and regular contributor to MoneyMetals.com. David talks about the state of the mining industry, the developing supply shortage in the silver market and how the set-up today might compare to the late ‘70s in precious metals. His comparison there just may surprise you. So don’t miss a terrific interview with David Smith coming up in just a moment.

Well, it appears that another so-called government shutdown looms. Just how damaging would a shutdown be to the economy and financial markets? You’ll hear some surprising facts that neither the Democrat nor Republican establishment leaders in Congress want to put out to the public later in this podcast.

First, though, let’s get to this week’s market action. Instead of getting a post-Fed bounce, the stock market is suffering a post-Fed slump. After Federal Reserve policymakers left rates unchanged last week, investors reacted not with excitement about the continuance of ultra-cheap money, but instead with concern about the weak economic outlook. At one point this week, the Dow Jones Industrials had shed more than 300 points to test the 16,000 level. Should the blue-chip average finish below 16,000, that would be its lowest weekly close of the year.

Precious metals, meanwhile, are faring better. As of this Friday morning recording, gold prices show a small weekly gain of 0.4% to trade at $1,145 an ounce. Silver prices got pushed down below $15.00 an ounce earlier this week. But the white metal rebounded on Thursday to bring prices back to break even on the week. Silver prices are down slightly so far today and are flirting with $15 once again and come in at $15.06 an ounce, down 1.2% since last Friday’s close.

Turning to the Platinum Group Metals, we’re seeing an extreme divergence – with palladium up big and platinum way down. The reason? A major scandal involving Volkswagen’s diesel vehicles in the U.S. – one which caused VW’s CEO to resign. Turns out that millions of vehicles were built to evade emissions standards – and those diesel autocatalysts use platinum. So platinum has taken a big hit, and palladium – used mostly in gasoline engine cars – has risen sharply. That’s why palladium prices are up a whopping 9.2% so far this week and are at $665 an ounce at present. But platinum now shows a weekly decline of 3.6% to trade at $948.

What’s significant about today’s platinum price is its relationship to the gold price. Platinum now trades at its biggest discount to gold in 30 years.

This may be a once in a generation opportunity for value investors to pick up some platinum on the cheap. One-ounce platinum bullion bars as well as Canadian and Australian platinum coins are available. And for those looking to start accumulating platinum on a smaller scale, Money Metals Exchange now sells tenth-ounce platinum bars. These smaller unit sizes of pure platinum are easy to accumulate and handy to have on hand. Platinum, like gold and silver, is a precious metal that will fare well when inflationary fears start gripping markets.

And speaking of fears, should you be fearful over the increasing likelihood of a government shutdown? Maybe not so much.

The new fiscal year begins next Thursday, October 1st. If Congress and the White House can’t agree on a deal to fund the government before then, that’s when the shutdown will begin.

However, the essential functions of government aren’t going to shut down. The national calamity that the Obama administration and the TV news media are warning could happen would only be a calamity for a small number of people. The so-called shutdown would involve non-essential federal employees staying home and groups like Planned Parenthood having their federal funding withheld. Yes, there would also be inconveniences inflicted on the public, such as national parks being shuttered.

But for the most part, the economy would get along just fine with a stripped down government. The bigger long-term financial threat is that the government re-opens with a bigger budget, an elevated debt ceiling, and no plans in place to arrest the unsustainable debt growth.

The reality is, taxpayers will get a raw deal no matter what. If the government stays open, the debt spending will continue unabated. If some government functions are temporarily defunded, taxpayers will still have to pay thousands of furloughed government workers their full salaries. They’ll effectively be enjoying a paid vacation.

We as taxpayers are damned if they do and damned if they don’t keep federal bureaucracies up and running. A superficial analysis of the partial government shutdown that occurred for 16 days in October 2013 shows that the economy suffered a $23 billion hit. That’s according to Moody's Analytics.

Yet for the fourth quarter of 2013, the economy expanded at a 2.9% rate, outpacing the 2.1% growth rate for the year. And following the shutdown, the stock market actually rallied. Treasury bond values also rose as yields fell. And there was no credit downgrade from any of the major ratings companies.

What could potentially trigger a ratings downgrade and panic in the markets is if brinksmanship over the government’s debt limit reemerges this fall. A debt ceiling standoff between the Republican Congress and Obama White House back in 2011 caused Standard & Poor's to downgrade the U.S. government’s credit rating from AAA.

The government actually hit its statutory $18.1 trillion debt ceiling in March. Since then, the Treasury Department has employed unconventional accounting maneuvers to prevent spending cuts from being implemented. The Treasury Department would run out of wiggle room by late November or early December if the debt ceiling doesn’t get raised.

It almost certainly will get raised, somehow, some way. And when it does, Republican and Democrat leaders will congratulate themselves for averting disaster. But all they will be doing is postponing and enlarging the debt disaster that will hit home at some point, in some form.

But raising the debt ceiling to fund Obama’s agenda will not come without a huge amount of flack from grassroots America. Flack about out-of-control deficit spending is getting more intense by the day. In fact, the heat has pushed Speaker John Boehner – a man at the center of most of the big government sellouts in recent years – to announce his resignation this morning, effective at the end of October.

If not through default, then through inflation. As former Federal Reserve chairman Alan Greenspan has noted, under our monetary system, the government need never formally default on any of its debts. That’s because the Federal Reserve possesses an unlimited capacity to buy government bonds with freshly created currency. But, and this is the key point to it all, it simply cannot guarantee the purchasing power of that currency if those loose monetary policies are to continue.

And now, without further delay, let’s get right to this week’s exclusive interview.

Mike Gleason: It is my privilege now to be joined by David Smith, senior analyst at The Morgan Report and regular contributor to MoneyMetals.com.

David it's always great to talk to you and since you and I haven't actually spoken for quite a while, how have you been doing?

David Smith: I've been doing well Mike and I always enjoy speaking with you. I think we're going to have a lot of fun today and probably even transmit some knowledge out there for other people.

Mike Gleason: That's definitely what we aim to do here, and it's great to have people like yourself join us so regularly. So thanks again for being generous with your time.

Well David, you follow the mining industry very closely, and to start out here I wanted to have you comment on the current situation with the miners. We've had a prolonged period of low spot prices, and I know it's got to be crushing mining industry companies, for many it's really just a matter of survival right now. So what are you seeing there, and what effect is this having on supply, specifically silver?

David Smith: It's difficult to make an across the board statement about where the miners are, or how they're responding because some of the biggest ones like Glencore, are still almost in death throws in terms of getting their act back together again, and sell off assets, this type of thing. But what I'm really encouraged by, and especially in regard to silver, are what I would call the primary silver producers, and as many as your listeners know about 70% of all the world's silver comes from base metal producers. For example, BHP Billiton is an example. The silver that they produce, even if it's millions of ounces a year, is just small potatoes for them because they make most of their money on lead, zinc, and copper, and even uranium.

But the primary silver producers, which there are less than two dozen in the world, get most of their income from silver itself, and they tend to be in Mexico, and Peru, and some of these locations. They also produce a fair amount of lead, zinc as well, and even a certain amount of gold. But their primary money comes from silver.

I'm looking at the charts on some of these, the ones that I follow, and they look very good to me, even as we have seen silver make new lows a few weeks ago, in the physical price, these stocks did not make new lows. In fact they were making and are still making, as you and I are talking, higher lows within the context of getting ready to make higher highs. So to me that's very encouraging, and some of these stocks I know very well, and I know their financial situation where they're actually at least trading dollars at the current prices, and they're going to be survivors. Those are the ones you want to watch for, and it looks to me like the mining sector is not going to completely blow away, although it has certainly looked like that over the last four and a half, to five years.

Mike Gleason: These mining companies, I would assume, at these prices are probably not exploring quite as much, and maybe that's going to hurt some of the silver production and silver supply in the coming years. It does take a while to get new projects on line. What are they doing in terms of exploration, and what kind of impact do you think that's going to have on the supply outlook?

David Smith: Many of them have certainly cut back, and if they’re exploration stocks they don't have any income, so they have to almost go into a wait and see mode. The ones that I really like to follow, and have a lot of confidence in, are ones that may have cut back a lot on the overhead expenses, and they're being very specific on the targets that they do for drilling. They are sitting on their cash, and they're spending it when necessary. Whether it's to make another acquisition for a property, or to update their mill, or to look at doing infill drilling where they've established good results from the main drill holes and they drill between them to get more resources identified.

They're doing this in a way that enables them to keep on doing their production, but they're kind of in a holding pattern until prices go higher. There's one company that I follow that is not producing at all now, they're up in the Yukon, they're on care and maintenance with their two mines. But the thing is, they are not going to produce until silver hits around $20.00 an ounce.

Mike Gleason: Certainly these sort of markets can always bring out the best in certain companies, the strong survive. We may see some consolidation there. From an overall perspective, some of the numbers are showing a decline in the overall global silver production. Steve St Angelo there at the SRSrocco Report has been reporting about how there's been a big decline in the last few months in global silver supply.

Now on the demand side of the equation, it looks like maybe industrial demand is flat to down based on a slowing global economy. But we have seen a massive increase in the retail demand for physical silver, since June specifically. The low spot prices have meant a huge amount of bargain hunters are continuing to see major value and are switching some of their paper dollars into something tangible in a big big way here.

So where do you see this heading? We've got pressure in two major areas of the supply-demand equation… declining global mine supply, overall anyway, and very strong investment demand. How do you think this is going to end up?

David Smith: You know Mike, I call these two factors tectonic plates of supply and demand. We have several things going on, as you mentioned. The industrial demand has dropped back, but the investor demand has more than made up for that. So we have a lot of new customers coming in, that I don't think bought metals before, and I think these people will be staying with us. In other words, they will add to the pool of investors that want to add to their silver holdings. I think that's going to keep demand strong.

In addition, we see countries like India, who, at the torrid pace that they're importing silver this year -- it could be 40% of the world’s production this year -- which is really a massive amount. It's several times more than they have been importing in recent years. So this demand factor that's going to keep on going, I think, is not going to subside quickly like it has the last few times. If you look at the price for 90% (silver bags) or what's called “junk silver”, the premiums, they're as high as they've been in the last several decades. The last two times this happened (was) in 2000, and 2008 was the second one... the premiums went up, then they dropped sharply there soon after.

I would not be surprised to see these premium stay elevated for quite a long time, because I think this time it will be different. And this duel between the paper derivative pushers in the futures contacts, (and) with the real world physical price that you and I have to pay for the metal, if we can find it, I think is going to become distorted at a point that the paper pushers are going to be much less relevant in determining the physical price than they ever have been in the past.

Mike Gleason: We really do have two markets there. We've got the paper price, that's set in the futures market, and then the physical price, where premiums have just been soaring. Junk silver, Silver Eagles, silver Maples... supply is just really tight and we're seeing premiums elevated. And that's how the two markets diverge from one another. There’s a physical market and (then) we've got a paper market. And people just need to understand that. That (higher premiums for the actual metal itself) is the physical market's response to paper under pricing of the market.

That's essentially what we've got... a huge amount of sellers in the features market that are driving the price down, while we've got massive buying in the physical market. And something has to give. It's an interesting thing to watch play out.

Now, and you mentioned it a moment ago, we have seen a big increase in new precious metals buyers here recently in the U. S. And there's some indication that this is a worldwide situation with folks seeking protections against the risks of all the paper based wealth out there. What are your insights about the apparent rise in new precious metals investors?

David Smith: It's difficult to get a handle on these now, but when you look at some of the sellers of metals to the retail sector, and they say, "oh we're up 200, and 300%," some of that certainly is additional buying from customers that have been around for a while. (But) my guess is that a big chunk of that are of people who have never owned the metals before. They finally have seen a lot of data, (and are saying) “we’ve got to have some protection here. We've got to have some insurance... we need to buy gold and silver.”

Again, I think these people are just making their first tranche of buying, and they're going to be consistent buyers. Now that they get the story and they're really starting to lose confidence about what's going on in our political system, and the economic system, and they can see how the Federal Reserve’s policies of the last seven or eight years have been detrimental to long term stability in our economy. (They) have indeed put us in a place where we haven't solved any of the problems that we had in 2008, they've only gotten worse. I think that's what's going to help continue to keep the demand elevated.

Going back just a minute to what we talked about, about the demand issue, and the difference between the paper and the physical price. In 2009, I remember this very distinctly, sliver was pushed on the paper price down to around $9.00 an ounce. Yet if you tried to find it at anything less than $12.00 to $15.00, you couldn't do it. People that have thought, and probably thought up until recently, "oh I'll wait until silver gets down to such-and-such a price," maybe it's $12.00 or $14.00, $15.00 whatever, and gets down to that point, and then suddenly they go out and they find that they can't find it. It's trading at $15.00 right now but they're going to pay $21.00, $22.00 for Silver Eagles -- if they can find them -- and they're going to wait for several months.

So this is the thing that people need to keep in min. You're going to see this constantly anytime we have the paper price where it is now, that the physical market is telling us that it doesn't make sense in relationship to the demand out there.

Also, the supply, and this is something which again, it's not something that we can say, "oh this is a trend." But i's really something to pay attention to, and that is... Steve St. Angelo has done a lot of good work on his SRSroccoReport.com site, we're seeing fairly substantial fall off in production, not just in one country, but in severalm In Australia, in Mexico, in Peru, and even in the United States. And most recently Canada. These are very large falloffs in supply production, right at the very moment when demand is going through the roof. Those two things don't make for lower prices. They make for higher prices, and they make for more difficulty in getting supply at all.

Mike Gleason: Expanding on that a bit, on the technical side of things, since I know you follow that very closely, do you think we're nearing a bottom in here? We do seem to be carving out a major floor of support in these current price ranges for gold and silver. Is that true in your view?

David Smith: I really think so. And as the late Yogi Berra who passed away a short while ago said, "it's difficult to predict the future." But the thing is, we have to look at it anyway and make an effort. And I really believe that we have either seen the lows in the price for silver for this particular down part of the cycle, the cyclical cycle within the larger secular bull cycle. If we have not seen the lows in price yet, it will be a spike low, it will not be another leg down. A lot of analysts think we're heading for that. I just don't see it. If you think about it this way... let's say there was another dollar or even two dollars on the downside, and even if that were to last for a while, compare that to what the upside is. The upside is literally, ten to twenty times perhaps, over the next few years where we are now in terms of price.

So the risk-reward ratio, even if you only assumed a move back up to $50.00. You have $2.00 on the downside of the risk, whereas a number times that on the upside. It certainly seems to me, you're never going to find something with no risk, and if you wait until there's no risk, that means the market is already determined what that information is, and there's also very little potential for reward. So to me, the risk-reward ratio is extremely attractive in here for physical holdings.

Mike Gleason: In talking about the potential for a big bull move in the metals eventually coming to fruition here in the present day, or the not-too-distant future... now the high times for gold and silver bugs was back in the late 70's and early 80's, and I guess, in relating that to today and what things could look like if our current floor does prove to be a bit of a springboard for things to come... for me David, this appears to be quite a different setup today, versus that period some three decades ago, when a big part of the price run up was mostly attributable to just a few people like the Hunt brothers, or the Saudis, who basically cornered the silver supply using the futures market.

But today, we've got significantly more industrial demand than we did then given the advancements in technology, medicine, alternative energy, and so forth – which is where a huge amount of silver goes -- (and now) it looks like we could have the masses starting to get involved in silver investing. So the cornering could come from all corners of the globe this time around. How would you relate where we are today compared to the late 70's and early 80's?

David Smith: I have a chart which is very fascinating, and it shows the current decline we've had since 2011 in gold and silver, and (if you) compared that with the bull market, as you mentioned that developed in the late 1970's, and I remember that very distinctly when gold lost half of its value, and then proceeded within... and this was over a period of a couple years after it had gone up to a new high. It then proceeded to build a bull market that, within a couple of years after that, had gone up over 800% from where its value had bottomed.

As you just said, the elements of this are so much more powerful and all pervasive than they were then. There was no internet, there was really no significant participation from Eastern nations, a very small percentage of the population was involved at all. The Hunt brothers and a couple of other big names were doing most of the buying on the futures exchange, and we didn't have the systemic issues that we do now. We have (not only) high inflation, this type of thing, but also the massive debt that we have, (which) is an order of magnitude larger than we had before. There's debt throughout the world. The economies are not being run properly in relationship to sustainable improvements for the majority of the people.

Everything, including the internet, which gives us instantaneous ability to buy and sell stocks, and the metals if we can find them. This is going to mean everything is going to be faster and more powerful than the last time around. You and I have, and the people listening to this podcast, have the ability to do research, and to make buying and selling decisions in our accounts, that only some of the very top brokerage houses had in the 1980's. If a company comes out with a new drill result we can go and check that on their website, we can look at other resources like Yahoo.com and we can find out, within a very short period of time, the type of information that we would wait days or weeks for from our broker, and it would take them a long time to put it together.

So I don't think people realize just how much information capability that they have at their fingertips, that was just a glint in someone’s eye in 1980. That's why prices move so quickly, that's why a stock of a company can double overnight. That's why we can see the $1.00 or $2.00 move in silver that might have taken weeks or months to take place before. To me it’s fascinating, and I think it's going to offer tremendous profit and insurance opportunities for people going forward.

The average person on this street, that informs themselves, and holds some physical metal for insurance purposes, and looks into some of these stocks, I think they're going to find over the next few years, it's going to be pretty amazing on the upside for them.

Mike Gleason: Finally David, before we let you go, I want to ask you about the great article that you wrote for us this week, and we'll encourage our listeners to go to MoneyMetals.com and read that, but please give us a brief summary of what you wrote about in that piece because you touched on a great principle when it comes to investing, and many things in life for that matter. That is the KISS method... talk about that briefly if you would.

David Smith: Well you know, Mike, I'm not an investment counselor so I can't give investment advice but I certainly give my thinking. From my reading and the experience I've had in going to these different mining operations, and this particular article -- which I really enjoyed writing -- it's about investing in a way. It's not only about that, but it's (also) about how you go about it and how you relate it to the other aspects in your life. If you're successful at your investing, you can do good and well at the same time.

If you get your money through honorable means, and you think about how you can help your fellow man, it can really be rewarding beyond whatever your bank account shows at any given time. So I wrote this article, about a man named Jim Teeny, who invented the Teeny nymph, which is a fishing fly that he started tying in the 60's, and he's still tying today. I know Jim, and I've fished with him, and I have so much respect for him. I got to thinking about how Jim approaches fishing, and there may be some correlations here about investing. I gave a little background about Jim, there's a nice video where he was interviewed recently, an eight minute one, and there's a hyperlink in the article that people can go to see about his interview, and see how he approaches things.

Then I looked at how he looks at fishing, and how he goes after his quarry, most of which he releases, and how that would relate to investing. I came up with several parallels that people could use and see the connection between fishing and investing. Then also think about how, when we do well, how we can help other people... whether it's members of our family, or people that we love and respect, or maybe someone that we run into that's really down on their luck.

And (with respect to) silver, and I love doing this, is taking a one tenth ounce silver, which you wouldn't think of that big of a deal, it's worth about $1.50 to $2.00 now in terms of the silver content. It's about the size of the dime that we used to have in our pockets, which were 90% silver. But these are three nines (.999), or four nines (.9999) fine. So they're pure silver. To just hand that to someone, whether it's a tip, or someone on the street, or whether it's someone that doesn't expect to be getting something, and see the glint in their eye. It really makes you feel really good that you've done some little good for someone, or give them an opportunity to go ahead and research on their own, what the idea of silver, holding silver in your hand, is all about.

I think this article, which again I enjoyed writing so much, and I think people will find the bigger picture of investing and what it really means. It isn't just about making money. It's about how you make the money, and what you do with it after you get it.

Mike Gleason: Well it's always enlightening stuff, and that's one thing that I love about your writing, and also you as a guest here on this podcast, and thanks again for your time, and your excellent insights as usual David. We certainly look forward to talking with you again real soon, so enjoy your weekend.

David Smith: You bet Mike, and I've enjoyed speaking with you, take care.

Mike Gleason: Again, to check out any of David’s insightful columns, just go to the “News” section on MoneyMetals.com, or just type in “David Smith” in the search box, and you'll get links to all of his work, including the afore mentioned article from this week, which is titled, More than Making Money: Living, Fishing, and Investing the Jim Teeny Way. Be sure to check that out.

Well that will do for this week, thanks again to David Smith... and check back next Friday for our next Weekly Market Wrap Podcast. Until than this has been Mike Gleason with Money Metal Exchange, thanks for listening, and have a great weekend everybody.

Mike Gleason is a Director with Money Metals Exchange, a national precious metals dealer with over 80,000 customers. Gleason is a hard money advocate and a strong proponent of personal liberty, limited government and the Austrian School of Economics. A graduate of the University of Florida, Gleason has extensive experience in management, sales and logistics as well as precious metals investing. He also puts his longtime broadcasting background to good use, hosting a weekly precious metals podcast since 2011, a program listened to by tens of thousands each week.